When rules and standards haven’t changed in almost 10 years, there’s certainly going to be much-needed clarification when new ones go into effect. That’s exactly what happened with the Global Investment Performance Standards (GIPS®).
The CFA Institute announced in July 2019 the anticipated revisions to GIPS — known as 2020 GIPS Standards — would become effective January 1, 2020, and would be included in reports for periods ending December 31, 2020. One of the largest areas the revised standards target relates to clarifications between reporting and disclosures surrounding two different types of pooled funds, leading to a flurry of questions around the topic.
What Is a Broadly Distributed Pooled Fund vs. a Limited Distributed Pooled Fund?
2020 GIPS Standards greatly focus on distinguishing between broadly distributed pooled funds (BDPF) and limited distributed pooled funds (LDPF). BDPF is defined as a pooled fund that would allow the general public to purchase or hold the pooled fund’s shares, and it is not exclusively offered in a one-on-one presentation. LDPF is any pooled fund that does not qualify as a BDPF.
How Do 2020 GIPS Standards Change for Pooled Funds?
Specifically, the revised standards impose requirements and recommendations surrounding:
- The placement of pooled funds in composites;
- Presentation and distribution requirements of GIPS Pooled Fund Reports, specific to both BDPF and LDPF;
- Calculation and presentation of performance returns for pooled funds; and
- Other marketing and GIPS advertising guidelines with respect to pooled funds.
Below is a summary of the more significant changes to the 2020 GIPS Standards, mainly relative to treatment of expenses for pooled funds, and some frequently asked questions the CFA Institute clarified throughout 2021.
1. Provision 4.c.11.d indicates that when presenting a GIPS Composite Report to a prospective investor for a pooled fund included in the composite, the firm must disclose the pooled fund’s current fee schedule and expense ratio.
Further clarification expanded on the difference between prospective investor and prospective client. The fee schedule and expense ratio of the pooled fund is not required to be included in the GIPS Composite Report if it is provided to a prospective client of the composite; it is only required when the report is provided to a prospective investor of the pooled fund.
Additionally, there is some confusion as to which fee schedules and expense ratios should be disclosed in a GIPS Composite Report relative to a pooled fund, particularly when there are multiple classes of fund shares. If the pooled fund has multiple fee schedules, the firm may use the highest fee schedule or include all fee schedules in the report; including a range of fee schedules would not satisfy this requirement.
Similarly, for pooled funds with multiple share classes, the firm may present multiple expense ratios or may present only the expense ratio appropriate to the specific prospective investor. The firm may also use the highest expense ratio applicable to a prospective investor in the pooled fund.
It is prudent to note that any performance-based fees or carried interest should also be included in the expense ratio. Presenting a range of expense ratios would also not satisfy this requirement. The CFA Institute also clarified that pooled fund expense ratios calculated for periods less than one year need to be annualized. Referring to another document, such as a prospectus or ADV for the fee schedule or expense ratio, does not satisfy this requirement. The fee schedule and expense ratios may be attached as an exhibit to the GIPS Report.
Finally, the specific names of the pooled funds should be disclosed in the GIPS Composite Report, and, if there are multiple pooled funds in a composite, the firm must disclose the fee schedules and expense ratios for each pooled fund.
2. 2020 GIPS Standards now require all pooled funds managed to the same strategy as separate accounts to be included in the same composite as those separate accounts. Unlike separate accounts, pooled funds typically incur many more expenses, and returns are calculated net of all expenses.
The CFA Institute provided additional guidance surrounding the ability to simplify the gross-of-fees return calculation, by way of adding back all fees and expenses deducted when computing the net return (with the exception of transaction costs). The firm can elect then to reflect net-of-fees returns by reducing by all fees and expenses (including custody, administrative, etc.) or can elect to solely reduce by the management fee, if proper disclosure is included in the GIPS Composite Report.
3. Including pooled funds in composites leads to complexities for certain pooled fund structures. Such structures include master-feeder funds, which incur expenses typically at the feeder level but for which investment management decisions are made at the master level, i.e., the master invests in underlying investments.
The CFA Institute expanded on this FAQ by focusing on two considerations:
- Evaluating the level of the investment structure that is effectively subject to investment management decisions, and
- Evaluating the level of the investment structure in which prospective investors can effectively invest.
Typically, the level in which prospective investors can invest with a master-feeder structure is in the feeder level; this is also the level that should be included in a composite. However, the clarification indicates it may be more appropriate to include the master fund in the composite. It is ultimately up to the firm to determine how to treat each composite, apply this methodology consistently, and ensure documentation is appropriate both in the firm’s policies and procedures and within the GIPS Composite Report. This aligns with reporting performance returns. If the firm chooses to include the master fund in the composite, with no expenses incurred for the master fund, the firm will need to determine an adjustment to arrive at net-of-fees return for the account in the composite.
Although 2020 GIPS Standards provide additional clarity surrounding the inclusion of pooled funds for performance reporting and other disclosure requirements, pooled funds and the impact for GIPS continues to be an ambiguous area for many firms. In reviewing the 19 FAQs posted by the CFA Institute this past year, approximately 12 relate to treatment of pooled funds in composites. Work with your advisers to fully understand this area for your firm.
>> See the complete response to the CFA Institute’s FAQs
Contact Lindsay Selick at email@example.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.